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1. Account for share dividends. 2. Distinguish share splits from share dividends. 3. Account for share buy-backs. 4. Report transfers to reserves. 5. Identify the elements of a company’s statement of financial performance. 6. Calculate earnings per share.
Chapter 15 - Companies: Retained profits, share splits and buybacks, and the statement of financial performance CHAPTER OVERVIEW In Chapter 14 you learned about share capital, cash dividends, share values, company income taxes, and other topics related to companies. We expand those topics in this chapter and learn about share dividends, retained profits and reserves and a company’s statement of financial performance among other topics. The learning objectives for this chapter are to: 1. 2. 3. 4. 5. 6. Account for share dividends. Distinguish share splits from share dividends. Account for share buy-backs. Report transfers to reserves. Identify the elements of a company’s statement of financial performance. Calculate earnings per share. CHAPTER REVIEW Retained Profits is the account that holds all the company’s net profits less net losses and fewer dividends declared, accumulated over the life of the business. A deficit or debit balance means net losses have exceeded net profits. Profit and Loss Summary is closed to Retained Profits at the end of each period. Retained Profits is not a ‘stack of cash’. The liabilities and shareholders’ equity show the source or funds, not their use. Objective 1 - Account for share dividends. Companies declare share dividends instead of cash dividends when they want to conserve cash or reduce the market price per share. Unlike cash dividends, share dividends are not distributions of company assets. A share dividend is a proportional distribution of the company’s shares to its shareholders. Thus, a share dividend affects only a company’s shareholders’ equity accounts; the result of a share dividend is a reduction in Retained Profits and an increase in Share Capital, while total shareholders’ equity stays the same. The effect of declaring a share dividend is to capitalise or transfer a portion of Retained Profits to Ordinary Share Capital. The entry is: Retained Profits Dividend Payable Dividend Payable Ordinary Share Capital XX XX XX XX A share split increases the number of issued shares and proportionately reduces the value of the share. A share split affects only the market value of the shares and the number of shares issued. No account balances are affected. Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 1 Objective 2 - Distinguish share splits from share dividends. Both share splits and share dividends increase the number of shares issued and may decrease the market price per share. The difference between share splits and share dividends is that a share split changes the par value (if the shares have a par value) of the share, while a share dividend leaves the par value of the shares unchanged; also a share dividend requires a transfer from Retained Profits while a share split requires no journal entry. Carefully review Exhibit 15-1 in your text for a summary of the shareholders’ equity effects of cash dividends, share dividends and share splits. Objective 3 - Account for share buy-backs. When a company reacquires (purchases or repurchases) some of its shares it is called a share buyback (in the US the shares available for buy-backs are known as treasury stock). The entry to record the buy-back is: Paid-up Capital Cash XX XX The debit balance in the Share Capital account reduces total shareholders’ equity. Note that a company never incurs a gain or loss by dealing in its own shares. Companies are likely to buy back some of their shares if they have surplus funds but insufficient profitable investment opportunities, or if they wish to change their gearing: proportion of debt verses equity financing. Share buy-backs may have significant tax advantages for some shareholders and are generally seen by shareholders as a positive. Objective 4 - Report transfers to reserves. Many companies obtain financing through long-term loans (Chapter 16). Creditors wish to ensure that funds will be available to repay these loans. Thus, loan agreements frequently restrict the amount of borrowing a company can undertake compared to their shareholders’ equity: debt ratio. A company may appropriate a portion of retained profits for a specific purpose or as a general reserve by debiting Retained Profits and crediting Reserves. By transferring an amount out of Retained Profits to a Reserve, management may be signalling its intention not to pay that portion in dividends. Retained Profits or Reserves are not funds set aside for a future use. The liabilities and owner’s equity shows the net sources of funds for the business; the assets show how those funds have been used. Retained Profits and Reserves have usually been already used to purchase inventory, buildings etc. not put aside as cash and/or marketable securities. Debiting Retained Profits and crediting, say, Building Replacement Reserve does not make available one cent to replace the building. 2 Chapter 15 Objective 5 - Identify the elements of a company’s statement of financial performance. Investors may want to examine the trend of a company’s earnings and the makeup of its profit. Therefore, the company’s statement of financial performance (as prescribed by AASB 1018 and IAS 1 Presentation of Financial Statements) starts with revenue and expenses from continuing operations, and follows with profit or loss from special, one-time gains and losses. See Exhibit 15-2 in your text for the division of operations into continuing and discontinuing. Ordinary (continuing) operations (activities) are expected to continue in the future. Profit from ordinary operations helps investors make predictions about future earnings. Profits from ordinary operations are shown both before and after income tax has been deducted. Unusual (abnormal) items are revenues or expenses from ordinary operations but are of such a size or nature that their separate disclosure is relevant in explaining the financial performance. Such items are included in ordinary operations but disclosed in a note. Detailed disclosure in the notes is also required of some revenue and expenses, especially borrowing costs and taxation. Discontinuing operations are from the segment of the business in which a firm no longer operated. Current profits or losses from this segment are not relevant when analysts are attempting to predict the company’s future results. Extraordinary gains and losses are both unusual and infrequent and are reported with the tax effect of the gross gain or loss. Extraordinary items are those that are unusual, not related to the normal operations of the business and not likely to occur in the future. Examples are natural disasters and expropriations by foreign governments of business assets. Prior period adjustments. If an error is made in recording a revenue or expense in a prior period, should the adjustment be made to the opening balance of Retained Profits or added onto this year’s revenues or expenses? AASB 1018 requires the latter, an all-inclusive or comprehensive profit figure. Therefore all revenues and expenses appear in a statement of financial performance; if prior period adjustments are significant, they would require separate disclosure. On occasion companies change an accounting method. When this occurs, it is difficult for financial statement users to compare consecutive years’ activity unless they are informed of changes. For this reason, the cumulative (total) effect of any changes in accounting principles is reported separately. This cumulative effect is also reported net of its related tax effect. Disclosure of Retained Profits. AASB 1040 Statement of Financial Position (and IAS 1) require changes in retained profits to be disclosed. See Exhibit 15.3 in the text. Objective 6 - Calculate earnings per share. Earnings per ordinary share is calculated as per AASB 1027 Earnings per Share (IAS 33 Earnings per Share). To calculate EPS divide net profit minus preference dividends by the weighted average number of ordinary shares. Weighted Average = Shares issued Fraction of year that shares were held Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 3 Review the example in your text to be certain that you understand how to calculate the weighted average number of shares. Dilution must be considered if preference shares can be converted into ordinary shares because there is the potential for more ordinary shares to be divided into net profits. Companies therefore provide basic EPS and diluted EPS information. It is common in North America for profits to be stated in EPS rather than in the almost meaningless and incomprehensible billion dollar amounts. Changes in Asset Revaluation Reserves, exchange differences on conversion of financial reports of foreign operations and any changes in retained profits on the adoption of a new accounting standard need to be disclosed separately at the bottom of the statement of financial performance. See exhibit 15-4 in your textbook. The reporting of other items affecting equity is consistent with the disclosure required by AASB 1031 Materiality studied in Chapter 12. TEST YOURSELF All the self-testing materials in this chapter focus on information and procedures that your instructor is likely to test in quizzes and examinations. I. Matching _____ 1. _____ 2. _____ 3. _____ 4. _____ 5. _____ 6. _____ 7. _____ 8. A. B. C. D. E. F. G. H. I. J. K. L. M. N. O. Match each numbered term with its lettered definition. _____ 9. AASB 1018 and IAS 1 _____ 10. all-inclusive or comprehensive _____ 11. share split _____ 12. share buy-back _____ 13. deficit _____ 14. convertible _____ 15. reserves _____ 16. discontinued operations Financing activities a change to current revenue or expense for an error of an earlier period gain or loss that is both unusual for the company and non-recurring a profit figure which would include prior period adjustments an accounting standard on the statement of financial performance normal continuing business activity a proportional distribution by a company of its own shares that affects only the owner’s equity section of the statement of financial position amount of a company’s net profit per ordinary share an increase in the number of shares coupled with a proportionate reduction in the value of the share date on which the board of directors announces the intention to pay a dividend date on which the owners of shares to receive a dividend are identified transfer of retained profits to a reserve by a formal journal entry the shares that a company reacquires an account that does not indicate funds set aside for future acquisitions when a company has issued equity which may be exchanged for ordinary shares a debit balance is Retained Profits declaration date earnings per share (EPS) extraordinary item prior period adjustments ordinary operations appropriation of retained profits date of record share dividend 4 Chapter 15 P. a segment of the business that the company is no longer involved in II. Multiple Choice Circle the best answer. 1. The correct order for dividend dates is: A. B. C. D. declaration date, record date, payment date record date, declaration date, payment date declaration date, payment date, record date record date, payment date, declaration date 2. Share dividends are recorded as a: A. reduction in retained profits B. decrease in cash C. decrease in a liability D. increase in profits 3. The market price of a share of Moule Limited’s ordinary shares is $60. If Moule declares and issues a 50% share dividend (one for two), the market price will adjust to approximately: A. $30 B. $12 C. $90 D. $40 4. The Dividend Payable account is reported in which section of the statement of financial position? A. current liabilities B. long-term liabilities C. current assets D. shareholders’ equity 5. The repurchase of shares will: A. decrease assets B. increase liabilities C. increase shareholders’ equity D. decrease profits 6. The buy-back of shares decreases the number of: A. forfeited shares B. current liabilities C. reserves D. ordinary shares 7. When a company splits shares: A. the number of issued shares increase B. the number of shares issued is unchanged C. retained profits decrease D. total assets increase 8. An appropriation of retained profits will: A. decrease total retained profits C. not affect total retained profits Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 5 B. increase total retained profits D. increase total assets 9. All of the following would usually be reported as extraordinary items on the statement of financial performance except: A. B. C. D. a flood loss the loss on assets taken by a foreign government the loss from industrial action by workers a loss from a terrorist attack 10. Prior period adjustments are found on the: A. statement of financial position B. statement of financial performance C. statement of cash flows D. statement of retained earnings III. Completion Complete each of the following statements. 1. Earnings per share are calculated by dividing _____________ by ____________________________. 2. A _____________ dividend is a non-cash dividend. 3. To be classified as extraordinary gains and losses on the statement of financial performance the item must be both _______________________ and __________________________. 4. A company may buy back its shares in order to: ___________________________________________________________________________ ___________________________________________________________________________ ___________________________________________________________________________ 5. Unusual (abnormal) items are reported in the notes but shown in the statement of financial performance as part of _____________________________________. 6. The P/E is the acronym for the ___________________________. 7. Preference dividends are ___________________________ from operating profit after income tax in the calculation of EPS. 8. A __________________________ occurs when shareholders return shares to the company and receive more shares in the exchange. 9. An error affecting net profits or loss in a previous accounting period is called a ___________________________________________________________________________ _. 10. An ________________________ occurs when retained profits are debited and a reserve account is credited. 6 Chapter 15 IV. Daily Exercises 1. Number the following statement of financial performance categories to show the order in which they should appear. _____ A. _____ B. _____ C. _____ D. Profits from ordinary activities after income tax Net profit Extraordinary items Gross profit 2. A shareholder owns 16,000 shares of Utronics Limited. If the company declares and issues a 25% share dividend, how many shares will the shareholder own? 3. Examine the information in Daily Exercise #2 above, but assume a five for four share split. How many shares will be owned after the split? 4. A company’s equity includes the following: Preference Shares $400,000 The company decides to buy back and retire its issued preference shares and is able to do so for a total of $460,000. Record the journal entry to buy back the preference shares. Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 7 5. Marli Limited has total Retained Profits of $2,970,000 and total Contributed Capital of $2,420,000 comprised of 1,210,000 ordinary shares. The board of directors then decides to transfer $1,950,000 of Retained Profits to a general reserve. Journalise the transaction. Prepare the shareholders’ equity section of the statement of financial position after the transaction. 6. Puang had 450,000 ordinary shares on 1/7/05. On 1/10/05 an additional 150,000 shares were issued and on 15/3/06 75,000 more shares were issued. Assuming Puang’s net profits for the year were $1,963,500, calculate earnings per share. V. Exercises 1. Indicate the effect of each of the following transactions on Assets, Liabilities, Contributed Capital, and Retained Profits. Use + for increase, - for decrease, and 0 for no effect. Contributed Capital Retained Earnings Assets A. Declaration of a cash dividend B. Payment of a cash dividend C. Declaration of a share dividend D. Payment of a share Liabilities 8 Chapter 15 dividend E. A share split F. A share buy-back 2. Wholesome Company had Shareholders’ Equity: Contributed Capital (55,000 ordinary shares, fully paid) $110,000 and Retained Profits of $28,000. On October 10 the market price of Wholesome’s ordinary shares was $3.20 per share and the company declared a dividend of $16,000 to be satisfied by the issue of further shares valued at $3.20 each. Wholesome issued the shares on November 22. Record the declaration and distribution of the share dividend. Prepare the shareholders’ equity section of the statement of financial position after the share dividend was paid. Date Account Debit Credit Shareholders’ Equity 3. Prepare journal entries for the following share buy-back transactions: 10/2/06 Repurchased 4,000 shares for $22 per share. In the explanation disclose the additional information required by AASB 1040 when shares are repurchased. Date Account Debit Credit Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 9 4. Hun Wan Trow Limited has the following shareholders’ equity at October 1: Contributed Capital (550,000 ordinary shares, fully paid) Retained Profits Total Shareholders’ Equity $6,050,000 1,540,000 $7,590,000 On October 10 Hun Wan split its ordinary shares four for one. Make the memorandum entry to record the share split, and prepare the shareholders’ equity section of the statement of financial position immediately after the split. Shareholders’ Equity 5. Baker Limited earned profits from ordinary activities after income tax of $1,407,000 in 2004/2005. The shareholders’ equity section of Baker’s statement of financial position revealed the following: Ordinary Shares (350,000 ordinary shares fully paid) Preference Shares (33,600 preference shares fully paid) $3,500,000 $1,470,000 The preference shares are entitled to $1.25 dividend per annum. There has been no change in the issued capital during the year. Calculate Baker’s EPS for the year. 6. Elizabeth Allen Limited’s accounting records contain the following information for the financial year ended 30/6/05: COGS Operating Expenses Extraordinary Loss Sales Revenue $ 735,000 $ 279,000 $ 150,000 $ 1,140,000 10 Chapter 15 Unusual Revenue Income Tax Savings (extraordinary loss) $ Income Tax Expense (ordinary operations) $ 36,000 60,000 $ 59,400 Prepare the Statement of financial performance and any notes that may be required. Statement of Financial Performance Note: VI. Beyond the Numbers Why would a company declare a share dividend or announce a share split when neither changes the balance in any asset or liability account and does not change the total shareholders’ equity? Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 11 VII. Demonstration Problems Demonstration Problem #1 Michael Movers Limited had the following transactions in 2005: August 16 August 30 October 1 October 28 December 10 December 28 December 31 December 31 Declared a cash dividend of $9.00 per share on 50,000 preference shares and $0.80 per share on the 50,000 ordinary shares. Paid the cash dividends. Split the ordinary shares three for one. Declared a dividend of $150,000 on the ordinary shares to be satisfied by the issue of 25,000 new ordinary shares to shareholders registered on November 10. Issued the share dividend shares. Purchased 12,000 of the company’s own ordinary shares at $24 per share. Earned a profit of $146,000 in the six months ended 31/12/05 and closed it to retained profits. Transferred $98,765 to the General Reserve. Record the transactions in the general journal. General Journal and Memorandum Aug 16 Aug 30 Oct 1 Oct 28 Dec 10 Dec 28 12 Chapter 15 Dec 31 Dec 31 Demonstration Problem #2 The following information relates to Hildebrand Holdings Limited at 30/6/04: $’000 Preference shares (36,000 issued, entitled to $1.50 annual dividend per share) Ordinary shares (180,000 issued) Sales revenue Sales returns COGS General expenses Selling expenses Interest expense Discount allowed Interest revenue Dividend revenue Income tax expense on ordinary operations Income tax expense on unusual gain Income tax saving on extraordinary loss Loss on sale of buildings Extraordinary loss Unusual revenue Dividend declared and paid on ordinary shares 900 2,898 5,301 135 2,871 639 783 207 63 45 171 252 31 97 90 243 72 108 Required: 1. Present the statement of financial performance in good form for Hildebrand. 2. Assume Hildebrand began the year with 150,000 shares of ordinary shares issued. On September 1, 2004, the company issued 75,000 additional ordinary shares. On April 1, 2005, Hildebrand repurchased 45,000 shares. Present earnings per share information. Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 13 14 Chapter 15 Requirement 1 (Statement of financial performance) Statement of Financial Performance Note: Requirement 2 (Earnings per share) Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 15 SOLUTIONS I. Matching 1. 2. 3. 4. I G B A 5. 6. 7. 8. E K J F 9. D 10. C 11. H 12. L 13. 14. 15. 16. O N M P II. Multiple Choice 1. A The board of directors declares a dividend on the declaration date, to shareholders of record on the record date; the dividend is paid on the payment date. A reduction in Retained Profits, not cash like normal dividends studied in the previous chapter. If the market price for one pre-dividend share is $60, then approximately the same market value will apply to the 1.5 post-dividend shares since the shareholder’s percentage ownership in the company has not changed. $60 / 1.5 shares = $40 per share. Dividend Payable is a current liability like any payable - see Chapter 11. When a share buy-back is completed cash is decreased and shareholders’ equity is decreased. Ordinary shares will be decreased, cash will also decrease, but only in extreme cases will reserves be decreased and liabilities are totally unaffected. When a company has a share split the number of shares issued or ordinary shares increases. Appropriating retained earnings has no effect on total retained earnings. It merely indicates that some retained earnings are not available for dividends. To be treated as an extraordinary item on the statement of financial performance an event must be unusual and infrequent. In today’s business environment industrial action by workers are neither, whereas the other listed items can be considered both. Prior period adjustments are corrections to the statement of financial performance as per AASB 1018 all-inclusive approach. 2. A 3. D 4. 5. 6. D A D 7. 8. A C 9. C 10. B III. Completion 1. net profit less preferred dividends, weighted average number of common shares issued 2. share 3. unusual in nature, infrequent in occurrence (Note that extraordinary items must be both unusual and infrequent.) 4. support the market price of the shares, use available surplus funds, change gearing 5. ordinary operations or ordinary activity (possibly continuing operations) 6. price-to-earnings ratio or simply price-earnings ratio 7. earnings per share 8. share split 9. prior period adjustment 16 Chapter 15 10. appropriation or transfer IV. Daily exercise 1. A. B. C. D. 2 4 (Note profit from ordinary activities is shown both before and after income taxes.) 3 1 2. Current holdings Dividend (0.25 4,000) Total 16,000 shares 4,000 shares 20,000 shares 3. The answer is 20,000 shares - the same answer. A five for four split means the shareholder receives one additional share for each four held. In other words, in terms of number of shares, there’s no difference between a 25% stock dividend and a five for four split. From the company’s perspective a share split leaves the same amount in Contributed Capital while a share dividend transfers an amount from Retained Profits to Contributed Capital. Both leave total shareholders’ equity the same. 4. Preference share Retained Earnings Cash 400,000 60,000 460,000 (Under Australian accounting regulations the cost of any share buy-back must be debited against shareholders’ equity. Having exhausted all the preference share capital, the next place to go was retained earnings.) 5. Journalise the transaction: Retained Profits General Reserve 1,950,000 1,950,000 The shareholders’ equity section of the statement of financial position after the transaction: Contributed Capital (1,210,000 full paid ordinary shares) Retained Profits* General Reserve Total Shareholders’ Equity * $2,970,000 - $1,950,000 = $1,020,000 2,420,000 1,020,000 1,950,000 5,390,000 Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 17 6. 450,000 3/12 600,000 5.5/12 675,000 3.5/12 = = = 112,500 275,000 196,875 584,375 EPS = $1,963,500 584,375 = $3.36 V. Exercises 1. Assets A. Declaration of a cash dividend B. Payment of a cash dividend C. Declaration of a share dividend D. Payment of a share dividend E. A share split F. Share buy-back 0 0 0 0 Liabilities + + 0 0 Contributed Capital 0 0 0 + 0 Retained Earnings 0 0 0 0* * Will only affect retained earnings in some circumstances. 2. Date 10/10 Account Retained Profits Dividend Payable Dividend Payable Ordinary Share Capital Debit 16,000 Credit 16,000 16,000 16,000 22/11 Shareholders’ Equity Contributed Capital (110,000 Ordinary Shares fully paid) Retained Profits Total Shareholders Equity 126,000 12,000 138,000 18 Chapter 15 3. Date 10/2/06 Account Paid-up Capital (4,000 $22) Cash Debit 88,000 Credit 88,000 On 10/2/06 4,000 shares were bought back for $88,000 with a corresponding reduction in Contributed Capital. 4. Called in the 550,000 ordinary shares and distributed four ordinary shares for each old share previously issued. Shareholders Equity Contributed Capital (2,200,000 ordinary shares, fully paid) Retained Profits Total Shareholders’ Equity 550,000 4 = 2,200,000 5. [ $1,407,000 - (33,600 $1.25) ] / 350,000 $1,365,000 / 350,000 $3.90 earnings per share $6,050,000 1,540,000 $7,590,000 6. Elizabeth Allen Limited Statement of Financial Performance For the Year Ended 30/6/05 Sales Revenue Less Cost of Goods Sols Gross Profit Other Revenue Operating Expenses Profits from Ordinary Activities Before Income Tax Income Tax Relating to Ordinary Activities Profit from Ordinary Activities After Tax Extraordinary Loss Less Income Tax Savings Net Profit Note: Unusual revenue included in other revenue $12,000 $ 1,140,000 735,000 405,000 36,000 279,000 162,000 59,400 102,600 ($150,000) 60,000 (90,000) 12,600 Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 19 VI. Beyond the Numbers Both share splits and share dividends increase the number of shares without changing the net assets of the company and therefore reduce the market price of each share. Unlike the US where share prices often trade in the hundreds of dollars, in Australia in August 2003 of the leading 100 Australian Shares (source: The Sun-Herald NSW) seventy-three were trading under $10 and twenty-six between $10.00 and $50.00; only one was over $50 (AMP Reset Preference Shares). A number of companies had achieved these low prices through share splits, share dividends or what was once called bonus share issues. (Some have also achieved low prices through consistently poor management.) There is a belief that if share prices become too high (‘high’ probably depends on the industry you operate in) the company shares will become less attractive. I am not sure why investors would rather buy 1,000 at $5 per shares rather than 100 @ $50 shares. With relatively small share splits or share dividends management may maintain the same cash dividends or even maintain an increasing trend in dividends. If you own 1,000 shares that pay a cash dividend of 40c per share ($400 total dividend) and there is a one for five share dividend or a five for four share split you end up with 1,200 shares; the same dividend per share results in $480 of dividend. VII. Demonstration Problems Demonstration Problem #1 Solved and Explained General Journal and Memorandum Aug 16 Retained Profits Dividend Payable, Preference Dividend Payable, Ordinary 490,000 450,000 40,000 $9.00 50,000 = $450,000 80c 50,000 = $40,000 Could debit Dividend Declared and at the end of the period close it to Retained Profits or debit it directly to Retained Profits. Strictly if it is a dividend out of last year’s profits debit Retained Profits; if it is a interim dividend out of expected profits this period it might be debited to Dividend Declared. Aug 30 Dividend Payable, Preference Dividend Payable, Ordinary Cash 450,000 40,000 490,000 Pay the dividend by debiting the liability and reducing it; credit Cash as it flows out of the company. 20 Chapter 15 Oct 1 Called in the Issued Ordinary Shares and distributed three new Ordinary Shares for each old share previously issued. A memorandum entry needs to be made so the number of issued shares can be shown in the statement of financial position (or note to the accounts) and dividends paid. The share register (or Contributed Capital Subsidiary Ledger) would need to contain this information. Oct 28 Retained Profits Dividend Payable 150,000 150,000 Declared the ordinary dividend (again you could have debited Dividend Declared and closed it to Retained Profits at the end of the period). Dec 10 Dividend Payable Contributed Ordinary Capital 150,000 150,000 Because it is a share dividend Contributed Ordinary Capital is credited; again the share register would need to note the issue of the additional shares. Dec 28 Paid-up Ordinary Capital Cash 288,000 288,000 Share buy-backs reduce cash and reduce capital. The reduction in Contributed Ordinary Capital will have to flow through to the share register; these shareholders will no longer receive dividends or vote at company meetings. Dec 31 Profit and Loss Summary Retained Profits 146,000 146,000 The standard closing entry was covered in Chapter 4 where we closed it to Capital because we only had one Owner’s Equity account at that stage. Dec 31 Retained Profits General Reserve 98,765 98,765 Reduce one item in shareholders’ equity by debiting it and increase the other by crediting it; no cash is involved and it is just as easy to reverse the entry and the profits (but not necessarily the cash) are available to pay dividends. Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 21 Demonstration Problem #2 Solved and Explained Requirement 1 (Statement of financial performance) Other revenue and dividend revenue could be presented below gross profits or after expenses. The format down to Operating Profits before Income Tax is the same as the multi-step format studied in Chapter 5. Unusual (abnormal) items are included in ordinary operations, so the tax associated with unusual items needs to be added to the tax for ordinary items ($252 + $31). Unusual items are then reported in a note to the accounts. Extraordinary items do need to be shown separately along with separate disclosure of their tax. Often extraordinary items are subject to special tax arrangements and the tax on them may be much higher or lower than the standard 30% or so. Hildebrand Holdings Limited Statement of Financial Performance For the Year Ended 30/6/05 Revenues: Sales Revenue Less Sales Returns Cost of Goods Sold Gross Profit Other Revenue Dividend Revenue Expenses: Selling Expenses General Expenses Interest Expense Discount Allowed Loss on Sale of Buildings Profits on Ordinary Activities Before Income Tax Income Tax Expense Relating to Ordinary Activities Profits from Ordinary Activities After Income Tax Extraordinary Losses Less Income Tax Savings Net Profit 5,301 135 5,166 2,871 2,295 72 171 2,538 783 639 207 63 90 1,782 756 (283) 473 243 (97) (146) 327 Note: Included in other revenue is unusual revenue of $72,000 as a result of, say, the repurchase of debentures. 22 Chapter 15 Requirement 2 (Earnings per share) 150,000 2/12 = 25,000 225,000 7/12 = 131,250 225,000) 180,000 3/12 = 45,000 180,000) Total 201,250 (2 months from 1/7/04 to 1/9/04) (7 months from 1/9/04 to 1/4/05 (3 months from 1/4/05 to 30/6/05 150,000 + 75,000 = 225,000 - 45,000 = Earnings $327,000 - (Preference Dividend of 36,000 $1.50 = $54,000) = $273,000 $273,000 / 201,250 $0.7175 Companies: Retained profits, share splits and buy-backs, and the statement of financial performance 23
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